>APOLLO TYRES: Rubber tailwinds

International rubber prices have declined by over 30% since the beginning of May in rupee terms with futures contracts suggesting that weak prices are likely to sustain. While domestic prices have declined a more modest 9%, historic trends suggest that they will converge in the
coming weeks. This bodes well for Apollo given that a 10% change in natural rubber prices implies a 270+ bps increase in India margins and 30%+ increase to consol EPS. Rubber is a much more critical driver for Apollo than volumes and suggests upside risks to FY13-14 earnings. BUY.

Rubber prices have been under pressure in recent weeks
International natural rubber prices have declined over 30% since early May in rupee terms to sub Rs140/kg while the December-January futures point to prices sustaining around the Rs140 mark. While the correction in domestic prices has been more modest so far (~9%), the historic correlation between the two suggests a pull back in domestic prices ahead. Domestic spot prices have already slipped to Rs178/kg. Given the historic premium of ~8% over international prices, a fall to around the Rs160/kg mark seems likely.

Significant positive for Apollo
Rubber is a key component of raw materials for Apollo (65% of India business RM in FY12). Within this, over 60% is natural rubber as the product mix is geared towards CV tyres. A 5% reduction in natural rubber costs points to a 14% increase in domestic Ebitda, 137bps improvement in margins and 16% increase in consol EPS. Factoring in a natural rubber price of 170/kg would imply a 45%+ increase to our consol EPS estimates.


Sensitivity to rubber higher than to volumes
While the soft domestic economic backdrop has raised worries about volumes, this is less critical for Apollo than rubber. A 5% reduction in our domestic volume estimate implies a 13% reduction in domestic Ebitda and 15% reduction in consol EPS estimates. This is actually less than the sensitivity to a 5% change in rubber despite being much less volatile than rubber prices.

Upside risks to earnings, maintain BUY
Given the tailwinds from rubber and the uptick in Europe margins visible in 1QFY13, we see significant upside risks to our estimates for Apollo Tyres. Even on current estimates, valuations are reasonable at 7.7x FY13 PE/1.3x FY13 PB. We reiterate our BUY recommendation on Apollo with a price target of Rs110, 25% upside. We see the worries around CCI as being overdone.

To read report in detail: APOLLO TYRES